Warren Buffett said: “Volatility is far from synonymous with risk”. So it seems like smart money knows that debt – which is usually involved in bankruptcies – is a very important factor, when you assess the level of risk of a business. Above all, Embraer SA (BVMF: EMBR3) carries the debt. But should shareholders be concerned about its use of debt?
When is debt dangerous?
Debts and other liabilities become risky for a business when it cannot easily meet these obligations, either with free cash flow or by raising capital at an attractive price. In the worst case scenario, a business can go bankrupt if it cannot pay its creditors. While it’s not too common, we often see indebted companies continually diluting their shareholders because lenders are forcing them to raise capital at a ridiculous price. By replacing dilution, however, debt can be a very good tool for companies that need capital to invest in growth at high rates of return. The first thing to do when considering how much debt a business uses is to look at its cash flow and debt together.
See our latest review for Embraer
What is Embraer’s debt?
You can click on the graph below for the historical figures, but it shows that Embraer had a debt of R $ 23.4 billion in September 2021, up from R $ 25.7 billion a year earlier. However, because it has a cash reserve of R $ 13.3 billion, its net debt is lower, at around R $ 10.1 billion.
Is Embraer’s track record healthy?
Zooming in on the latest balance sheet data, we can see that Embraer had R $ 16.1 billion in liabilities due within 12 months and R $ 25.1 billion in liabilities due beyond. On the other hand, he had cash of R $ 13.3 billion and R $ 5.42 billion in receivables due within one year. Thus, its liabilities exceed the sum of its cash and (short-term) receivables by 22.4 billion reais.
The lack here weighs heavily on the R $ 14.2 billion business itself, as if a child struggles under the weight of a huge backpack full of books, his gym equipment and a trumpet. . We would therefore monitor its record closely, without a doubt. Ultimately, Embraer would likely need a major recapitalization if its creditors demanded repayment.
In order to measure a company’s debt relative to its profits, we calculate its net debt divided by its earnings before interest, taxes, depreciation and amortization (EBITDA) and its profit before interest and taxes (EBIT) divided by its interest. debtors (its interest coverage). The advantage of this approach is that we take into account both the absolute amount of debt (with net debt versus EBITDA) and the actual interest charges associated with this debt (with its coverage rate). interests).
Low interest coverage of 0.88 times and an unusually high net debt to EBITDA ratio of 8.9 hit our confidence in Embraer like a punch in the stomach. This means that we would consider him to be in heavy debt. A buyout factor for Embraer is that it turned last year’s loss of EBIT into a gain of R $ 1.0 billion over the past twelve months. The balance sheet is clearly the area to focus on when analyzing debt. But ultimately, the company’s future profitability will decide whether Embraer can strengthen its balance sheet over time. So, if you want to see what the professionals think, you might find this free analyst earnings forecast report interesting.
But our last consideration is also important, because a business cannot pay its debts with paper profits; he needs hard cash. It is therefore important to check to what extent its earnings before interest and taxes (EBIT) are converted into actual free cash flow. Over the past year, Embraer generated free cash flow amounting to a very solid 86% of its EBIT, more than we expected. This positions it well to repay debt if it is desirable.
Our point of view
On the face of it, Embraer’s net debt to EBITDA left us hesitant about the stock, and its interest coverage was no more appealing than the single empty restaurant on the busiest night of the year. But at least it’s pretty decent to convert EBIT into free cash flow; it’s encouraging. Overall, we think it’s fair to say that Embraer has enough debt that there is real risk around the balance sheet. If all goes well it may pay off, but the downside to this debt is a greater risk of permanent losses. The balance sheet is clearly the area to focus on when analyzing debt. But at the end of the day, every business can contain risks that exist off the balance sheet. For example, we discovered 1 warning sign for Embraer which you should know before investing here.
At the end of the day, it’s often best to focus on businesses that don’t have net debt. You can access our special list of these companies (all with a history of profit growth). It’s free.
This Simply Wall St article is general in nature. We provide commentary based on historical data and analyst forecasts using only unbiased methodology and our articles are not intended to be financial advice. It does not constitute a recommendation to buy or sell shares and does not take into account your goals or your financial situation. Our aim is to bring you long-term, targeted analysis based on fundamental data. Note that our analysis may not take into account the latest announcements from price sensitive companies or qualitative documents. Simply Wall St has no position in any of the stocks mentioned.
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